Nonprofit Boards and Alternative Investments

W. Scott Simon is a principal at Prudent Investor Advisors, a registered investment advisory firm. He also provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. Simon is the recipient of the 2012 Tamar Frankel Fiduciary of the Year Award.

One of the great tenets of modern prudent fiduciary investing is that no investment under consideration for inclusion in a portfolio is prudent or imprudent per se. The Prefatory Note to the 1994 Uniform Prudent Investor Act (UPIA) states, in part: "[The UPIA] makes five fundamental alterations in the former criteria for prudent investing. All are to be found in the [1992] Restatement [(Third) of Trusts from which the UPIA is derived]." One of these alterations is that "[s]pecific investments or techniques are not per se prudent or imprudent. The riskiness of a specific property, and thus the propriety of its inclusion in the trust estate, is not judged in the abstract but in terms of its anticipated effect on the particular trust's portfolio." (Restatement (Third) of Trusts (Prudent Investor Rule), section 227, comment f, page 24.)

Section 2(e) of the UPIA states: "A [fiduciary] may invest in any kind of property or type of investment consistent with the standards of [the UPIA]. … The premise of [UPIA] subsection 2(e) is that trust beneficiaries are better protected by the [UPIA's] emphasis on close attention to risk/return objectives as prescribed in [UPIA] subsection 2(b) than in attempts to identify categories of investment that are per se prudent or imprudent." (Restatement (Third) of Trusts (Prudent Investor Rule), section 227, comment f, page 24.)

Fiduciaries subject to a state's statutory adaption of the UPIA are no longer permitted to make investments on the basis of some statutorily sanctioned list of preapproved investments, such as Treasury notes or bank certificates of deposit. In addition, even though no particular investment or type of investment is to be pigeonholed as "prudent" or "imprudent" in the abstract, that's not to say that a fiduciary cannot conclude in a particular situation that an investment it is considering for inclusion in a portfolio must be rejected because it's just "too risky." In fact, a fiduciary responsible for some portfolio of money will, as a practical matter, pretty quickly narrow down the investments that he or she would likely consider including in the portfolio.

This brings me to the inclusion of alternative investments in portfolios run by nonprofits. Many boards of trustees at nonprofits with pools of money north of, say, $25-$50 million have been targeted over the last decade or so by large consulting firms that have advised them to invest in so-called alternative investments. I've run across a number of instances like this and thought that my observations might be of interest to advisors who are already active in the nonprofit arena and those who would like to get into it.

Nonprofit Boards of TrusteesMany trustees who are on the boards at nonprofits have an emotional bond with their nonprofit and the mission it seeks to fulfill. That's why they're very willing to donate so much of their time and energy to helping carry out that mission. These trustees are always very successful people in their community--which is one very good reason why they're asked to be on the boards at nonprofits in the first place.

Although they've been successful in their respective fields, many are usually not experts in investing. The only experience that these trustees have had is to intone the usual mantras of active investing: "Smart" experts can beat the market; or, because this or that mutual fund (or whatever form of investment) has had a stellar track record of performance (over whatever period), it will naturally continue in that vein in the future; or, no self-respecting investor should be caught not holding Facebook stock, and the like.

Some trustees with this worldview of investing can be easy marks for some of the large national consulting firms (as well as others) that provide advice to boards at many larger nonprofits in America. The individual advisors at these firms are always nice and very likable people; indeed, that's precisely why they are selected as advisors to the boards in the first place. (Personally, I've never met a highly paid advisor who isn't a likeable person.)

W. Scott Simon is an expert on the Uniform Prudent Investor Act and the Restatement 3rd of Trusts (Prudent Investor Rule). He is the author of two books, one of which, The Prudent Investor Act: A Guide to Understandingis the definitive work on modern prudent fiduciary investing.

Simon provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. He is a member of the State Bar of California, a Certified Financial Planner, and an Accredited Investment Fiduciary Analyst. Simon's certification as an AIFA qualifies him to conduct independent fiduciary reviews for those concerned about their responsibilities investing the assets of endowments and foundations, ERISA retirement plans, private family trusts, public employee retirement plans as well as high net worth individuals.